Tuesday, July 8, 2008

Natural Disasters as Engines for Growth

Yesterday, I ran across this interesting post by Don Boudreaux over at Cafe Hayek. The reporter (preparing this story for The Boston Globe) was asking whether natural disasters like the recent earthquake in China, can actually be helpful by causing a rapid upgrade in technology and infrastructure as the region is rebuilt. Many of Boudreaux's readers rightfully identified the usual economic arguments against such a view.

I thought Boudreaux's main argument, that businesses constantly reinvest in new, more productive capital without the impetus of a disaster was good -- but with one caveat. To accept the argument, there is an assumption of a market economy, where investment is largely driven by the individual owner seeking advantage in the market. I'm not confident that his point would necessarily hold in a system where many decisions are still largely driven by a centralized authority. And while Don is on the mark about the opportunity cost attending the rebuilding (how might the productive resources involved been otherwise used); it is possible that disasters may reprioritize the use of resources in a beneficial way.

Regarding the article, I find the reporter's use of the "creative destruction" analogy totally misplaced. Schumpeter's concept of creative destruction applied the entrepreneurial process of improvement and replacement. It is a natural process, involving constant tinkering and tweaking to apply new ideas and ways of doing things. The entrepreneur is creating new human capital, and it is that creation that destroys the old industry or method. Earthquakes, hurricanes, floods and tornados create little more than the need to replace and repair. Any creation comes as a result of the destruction. Schumpeter's idea reversed the sequence.

I think this discussion provides some possibilities for discussion with your students. Can or does disaster create growth? Does destruction lead to something better in the long run? (Here's an opportunity to test their time horizon by borrowing from Keynes: "In the long run, we're all dead.") If destruction is beneficial to the economy, why are vandalism, arson and willful destruction crimes? Shouldn't they be encouraged?

I look forward to your thoughts and comments.

Rick Matoon, one of the economists at the Federal Reserve Bank of Chicago and an old friend, just posted on the Assessing the Midwest Floods of 2008 (and 1993). It provides a good comparison of the two events, and a solid explanation for those who think natural disasters are really engines for growth.

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